There are many reasons small business owners need to determine the value of their small business. Everything from raising a new round of funding to applying for small business loans and transferring ownership requires some way of estimating the company’s value. Wherever you are in your business’s lifecycle, you’ll want to know how to value a small business sooner rather than later. Feeling confident in your appraisal will help you accurately determine how to pitch investors and raise funding, or price your business to find the right buyer.
What is a Business Valuation?
A valuation represents your company’s total worth. You’ll calculate your business’s value with a specified formula, taking into account your assets, earnings, industry, and any debt or losses. Business valuation services are also available to entrepreneurs who feel they need some assistance in this process. There are many kinds of business valuation methods out there, and some will serve you better than others, depending on your situation. We have listed common business valuation methods below:
- Market value business valuation method
- Asset-based business valuation method
- ROI- based business valuation method
- Discounted Cash Flow
- Capitalized of Earnings
- Multiples of Earnings
- Book Value
It is important to note that what worked for your business in the past might not even work for you now. Factors like the size of your business, your growth rate, your industry, your stability, your profitability, and the reason why you need a valuation in the first place will all affect which method you choose. Regardless of your business situation, we absolutely recommend hiring business valuation services to receive the most accurate possible calculation of your business’s worth.
Keys to Determine the Value of a Small Business
1. Understand Your valuation
Unless you have a natural born knack for numbers, business valuation isn’t the easiest process. It is essential to understand some key terms whether you hire business valuation services or not.
Seller’s Discretionary Earnings
If you are familiar with EBITDA you may already be familiar with SDE. EBITDA stands for earnings before taxes, depreciation, amortization which essentially equals the pure net profit of a business.
Small business owners need to calculate SDE to determine the true value of their business for a new owner. Seller’s Discretionary Earnings include expenses like income reported to the IRS and noncash expenses. Additionally, you will need to add back in the owner’s salary and owner’s benefits into your SBE calculation. Typically, Large businesses use EBITDA calculations to value their businesses, and small businesses use SDE since small business owners often expense personal benefits.
SBE Multiples
Your SDE represents the true, monetary value of your business, but your SDE multiple values your business according to industry standards. There’s a different SDE multiple for every industry. Your particular business’s SDE multiple will vary based on market volatility, where your business is located, your company’s size, assets, and how much risk is involved in transferring ownership. The higher your SDE multiple, as you might expect, the more your business is worth.
2. Organize Your Finances
Since the business valuation process is complicated, you may want to consider consulting professional business valuation services or an accountant that specialized in valuation rather tackling it alone. However, small business owners are fully capable of valuing their business using their own resources. First, it is essential to get financial information in order.
Before even thinking about how to value your small business for sale, both sellers and buyers should organize all financial records. Without this organization, both parties risk inaccurate calculations.
Your small business will need the following documentation
– Financial statements from the last three fiscal years and the most recent interim financial statements.
– Budget for the next fiscal year and projections for the coming years.
– Corporate income tax statements (including all schedules) for the most recent fiscal year
– Shareholder agreement- It contains information such as how to repurchase shares, buyback formulas, restrictions on share distributions, etc., which impacts a company’s value and or the negotiability of shareholders’ interests.
– Loan agreements- In order to establish the company’s future financial commitments, and it contains information regarding creditor requirements and restrictions that affect the company’s ability to distribute its earnings, as well as its value.
– Copy of leases- In order to verify whether the business location will be available for multiple years and whether there are renewal options.
– Details of advances to related parties and transactions between related parties.
– List of passenger vehicles registered to the company name over the last three years and the names of the main users of these vehicles.
– Summary of Remuneration Paid (T4), as well as T4 forms for the past three years.
– Current life insurance policies: The amount of coverage roughly indicates the shareholders’ value to the company when insurance was arranged, in order to provide liquid assets to buy out a shareholder in the event of his/her death.
– Access to the Minute Book: It contains the details of all of the company’s share capital transactions and indicates the value by the shareholder.
– Statements from business credit cards used by executive shareholders (and members of their family) from the last three years, as well as executive shareholders’ expense accounts from the last three fiscal years.
3. Take Stock of Your Assets
It may seem difficult to distill the value of your entire business to an exact number. But if you are selling your business, you have to put some number on your operation, especially if you want to be compensated for what you have built, taking into account all kind of equity.
Your best angle is to make a list of the production, property, and resources that comprise your business—assets and liabilities, cash and investments, employees, and intellectual property. Later, too, you can use this list to create an overview of your company’s value for potential buyers. This is another opportunity to seek the counsel of a mentor or a professional advisor, who can provide insight into your business’s assets from a more objective perspective.
4. Research Your Industry
Familiarity with your industry is crucial when conducting a business valuation. Buyers need to become experts on that business’s industry before making an offer. On the sell side, a deep understanding of your industry’s trends can help you reach an informed value that reflects your business assets as well as the current market.
Final Thoughts
No matter where you are in your business’s lifecycle, learning how to determine a business’s value is a great way to better understand your own business’s finances and assets within the context of your industry. Whether or not you’re valuing your business to prepare for a sale, having an accurate number in hand can only be positive. Once you’re confident in your valuation, you can mobilize your knowledge about your assets and earnings to make decisive improvements or necessary changes. Plus, knowing the value of your business can help you navigate any unexpected market turns or inbound offers.
Limitless Investment and Capital Business Valuation Services
Limitless Investment & Capital is highly experienced in business valuation, economic damage assessments, forensic accounting analysis, and support services. The members of our professional staff hold the distinguished Accredited in Business Valuation (ABV) credential and Certified in Financial Forensics (CFF) credential from the American Institute of Certified Public Accountants, as well as holding the Senior Appraiser Designation from the American Society of Appraisers, Certified Valuation Analyst from the National Association of Certified Valuators and Analysts and the Certified Fraud Examiner designation. We have significant experience as testifying experts.
Whether you are looking to expand your business through acquisition, need forensic accounting analysis, value enhancement strategies, or economic damage assessments, a business valuation can play a key role in helping you achieve your financial goals. Contact us TODAY to get started!